India Ratings and Research (Ind-Ra) opines that auto ancillaries are likely to witness a second consecutive year of double-digit revenue contraction in FY21, primarily on account of the disrupted operations caused by the countermeasures implemented to prevent the spread of COVID-19. These are likely to lead to lower income levels, weaker consumer sentiments, production disruptions, decreased industrial output as well as lesser movement of vehicles, resulting in a decline in global automobile demand and thus lower revenue and profitability for auto ancillaries in FY21. Ind-Ra expects entities with a large reliance on overseas markets to face a higher demand risk as the key markets of the US and Europe have been the most impacted by the virus, which could lead to uncertain business conditions.

US and Europe Being the Largest Export Markets: India exports about 27% of its automotive components production. The US, Germany and UK are the largest export markets for auto components globally and account for 25%, 7%, and 4%, respectively, of India’s exports; Italy also accounts for 4%. Over the past few years, India has emerged as the sourcing hub for many original equipment manufacturers (OEMs) globally due to its cost effectiveness in production and favourable geographical positioning to key markets such as Europe and Middle East. The growth of exported components outpaced the overall growth of Indian auto components industry in FY18 and FY19. In 1HFY20, while the domestic auto components sector recorded a revenue decline of about 10.1% yoy, exports recorded modest growth of 2.7% yoy (in USD terms). The domestic components suppliers have also been expanding their exports exposure to diversify their revenue streams and limit dependence on the domestic market, while improving profitability as exports are typically higher margin orders.

 

Demand Risk Coupled with Liquidity Issues a Double Whammy: Fitch Ratings Ltd estimates the world GDP to fall by 3.9% in 2020, with a GDP contraction of 5.6% in the US and 7% in the eurozone and does not expect them to recover to the pre-COVID 19 levels before end-2021. As per Ind-Ra’s discussions with portfolio companies, there have till date not been any export order cancellations; however, the agency believes that order offtake by the customers in these geographies could be slower than Indian OEMs in light of  a wider spread of coronavirus which could lead to prolonged shutdowns and a continued subdued demand. Furthermore, OEMs could postpone new model launches and investment plans, which would defer order offtake. While most OEMs in the export market had made timely payments to their vendors, they could renegotiate for a longer credit period amid uncertainty pertaining to demand recovery. Furthermore, there have been instances of complete drawdown of revolving credit facilities by the global OEMs, which reflects the stress on their liquidity position. From March 2020, Fitch Ratings has also taken downward rating actions on these OEMs on the expectation of a weakened credit profile. As exports market already carry a higher receivable cycle of 90-120 days compared to 45-60 days period in domestic market, any further stretch in the receivable cycle could stress the working capital cycle of domestic auto ancillaries. 

To naturally hedge forex exposure, some companies with orientation towards non-domestic markets had taken external commercial borrowings pre-COVID-19 pandemic on which the debt moratorium regulatory package is not applicable, thus adding to liquidity concerns. Also, while many companies have applied for ad-hoc limits from the banks, the same is subject to the approval of respective banks. 

Moreover, if COVID-19 is not contained timely, governments globally to boost their own economy could promote local production leading to uncertainties with regard to trade restrictions. Any measures making imports more costly may worsen the situation for Indian ancillaries that had undertaken capex to cater to non-domestic markets. 

Oil Dependent Economies Could Add to Demand Woes:
India exports around 12% of the total auto components to economies with reliance on crude oil (such as Africa and Latin America). Prices of crude oil (Brent - spot) declined by approximately 78% over January-April 2020. While these geographies have seen a relatively smaller number of COVID-19 cases, the sharp price decline of crude oil is likely to affect the overall economy of these nations, in turn impacting auto demand. In FY16, when crude oil prices had last seen a fall from previous highs, auto component exports had recorded a decline of 2.7% (in USD terms). The companies are also exposed to any decline in the export of vehicles by domestic OEMs due to a lower demand.


Forging to be Worst Affected: Under the various segments of auto ancillaries, forging is likely to be worst affected as it derives about 60% of its revenue from non-domestic markets while diesel engine and tyres derive approximately 20%. Forging is a capital-intensive industry, and companies undertook capex in FY19 to cater to the increased demand of US-Class 8 trucks, the returns on which would now be deferred for at least a year. Diesel engines are anyways facing challenges related to a structural shift towards petrol cars globally. Tyre companies are also in the middle of their capex cycle, however they are shielded to an extent as the companies have high exposure to the replacement segment even in the exports market. Industry segments such as batteries and wiring harness, which generate less than 10% of revenue from exports, are likely to be the least affected. 



Profitability to Remain Subdued: Ind-Ra expects that the auto ancillaries industry on an average could record at least 100bp EBITDA margin decline in FY21 and the profitability decline for export focused auto ancillaries could be steeper as exports earn higher margins. The lower commodity prices could aid the profitability for the sector, though only to a limited extent, due to pass-through agreements with OEMs and OEMs’ higher bargaining power. Also, some benefit may accrue to companies with overseas manufacturing units, as certain economies have announced support measures to meet part of the fixed costs during the shutdown period. A depreciated rupee rate could partly offset the decline in sales volumes; however, the benefit is not expected to be significant. 

T
he revenue and profitability of auto ancillaries focused on domestic markets are likely to fare better due to higher content per vehicle on the back of evolving regulatory norms including BS-VI applicable from 1 April 2020. 

Impact on Ind-Ra Rated Portfolio:
Of Ind-Ra’s rated portfolio, 31% of the companies derive more than 20% of their revenue from overseas, while another 10% derive more than 50% of their revenue from overseas. Ind-Ra believes that entities in the AA category and above could see some delays in achieving the expected deleveraging ; though adequate liquidity buffer would help them sail through a temporary increase in leverage due to a decline in operating metrics. However, certain entities in the A and BBB categories, with high leverage or lower liquidity buffers, will remain vulnerable amid the current situation.


Notes::

- C represents company followed by rating category.
- X axis represents projected net leverage for FY21 and Y axis represents liquidity cover. Size of the bubble reflects % contribution of overseas markets to revenue.
- Net leverage calculation considers a 15% demand decline and 1% EBITDA margin drop in FY21.
- Liquidity cover has been calculated for the near term considering the available liquidity resources as of 31 March 2020 and no revenues in April 2020 against continuing fixed costs in the month as well as debt and interest payments for April and May 2020. 


SOLICITATION DISCLOSURES

Additional information is available at www.indiaratings.co.in.

Ratings are not a recommendation or suggestion, directly or indirectly, to you or any other person, to buy, sell, make or hold any investment, loan or security or to undertake any investment strategy with respect to any investment, loan or security or any issuer.

DISCLAIMER

ALL CREDIT RATINGS ASSIGNED BY INDIA RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.INDIARATINGS.CO.IN/RATING-DEFINITIONS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE WWW.INDIARATINGS.CO.IN. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. INDIA RATINGS’ CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE.

Analyst Names

  • Pallavi Bhati

    Senior Analyst
    India Ratings and Research Pvt Ltd DLF Epitome, Level 16, Building No. 5, Tower B DLF Cyber City, Gurugram Haryana - 122002
    0124 6687256

    Shruti Saboo

    Associate Director
    0124 6687265

    Media Relation

    Ankur Dahiya

    Manager – Corporate Communication
    +91 22 40356121